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Effectiveness of OMT Programme Called into Question

Feb 12, 2014

The ECB's OMT programme, should it ever be put into practice, hardly seems capable of achieving its official goal, namely to restore the monetary policy transmission mechanism in the Eurozone. These are the findings of a recent CESifo Working Paper by the researchers Timo Wollmershäuser, Nikolay Hristov (both at the Ifo Institute), Thomas Siemsen (University of Munich) and Oliver Hülsewig (Munich University of Applied Sciences and Ifo Institute). The OMT programme is consequently unsuitable as a monetary policy instrument.

In their study the researchers examine the extent to which any intervention made by the ECB within the OMT programme could actually contribute to removing disruptions in monetary policy transmission. At the core of their analysis is the question of whether bank lending rates would actually fall in the crisis-afflicted countries if the ECB were to achieve a reduction in the yields for sovereign bonds with the help of open market purchases. The results of the study show that the essential precondition for the success of the OMT programme, namely a close link between interest rates on bank loans and government bond rates, cannot be empirically proven. Although falling government bond rates may lead to a decrease in both short-term and long-term bank lending rates, transmission is far from complete and has weakened significantly since the onset of the crisis.

Although simulations of open market purchases in the framework of the OMT programme show that interest rates on loans in the crisis-afflicted countries could be lastingly reduced, this would require ongoing and massive interventions by the ECB, since decreases in bank lending rates , required to restore an appropriate monetary policy transmission, are very sluggish. Cautious estimates indicate that the ECB would have to make open market purchases totalling up to 250 billion euros over a period of two years. This would correspond to around 37% of the government bonds outstanding with maturities between one and three years emitted by crisis-afflicted countries. It would consequently make the ECB one of the main creditors of those countries. Regardless of the political legitimacy of such intervention – Article 124 paragraph 1 of the Treaty on the Functioning of the European Union prohibits the ECB from monetizing government debt - such massive open market purchases entail problems that cannot be foreseen. On the one hand, the ECB would endanger its political independence, since it would lay itself open to blackmail due to high exposure to sovereign risk in its balance sheet. On the other hand, the ECB may be perceived as the "problem solver of last resort", inducing the crisis-afflicted countries to reduce their political efforts to regain international competitiveness via structural reforms.